Impact investment in Europe is bracing for the biggest regulatory switchup in the last five years.
Last month, the European Commission proposed a set of amendments to the Sustainable Finance Disclosure Regulation (SFDR 2.0). The new proposal is seeking to address the shortcomings of the current regulation by setting clearer standards for what sustainability-related investment products must demonstrate.
One change coming includes a new categorisation system designed to make it easier for financial products to make ESG claims within one of three categories. The first category to be introduced — “Transition” — is for funds investing in companies that are not yet very sustainable but on a path to improve.
The ESG “Basics” category covers funds that have a variety of ESG investment approaches but don’t have a strong sustainability-objective.
Finally, the “Sustainable” category is for funds with clear, measurable sustainability goals.
With the redrafted regulation, the Commission hopes to make sustainability disclosures and investments easier to understand, more trustworthy and more stringent on greenwashing.
Cornelia Frentz, director of governance and sustainable investing at the European Circular Bioeconomy Fund (ECBF), says the fund is already meeting the SFDR 2.0 requirements.
The VC invests in growth-stage companies aiming to mitigate climate change and contribute to biodiversity, and must meet a robust set of requirements.
What the regulation requires is that all sustainable products in the EU need to demonstrate measurable impact.
SFDR 2.0 may bring challenges but impact is already at the heart of ECBF’s business model, Frentz says. “What the regulation requires is that all sustainable products in the EU need to demonstrate measurable impact, which means that they need to contribute to either environmental or social objectives,” she says.
“With SFDR 2.0, funds need to write down at least one environmental objective that they contribute to in order to be sustainable,” Frentz says.
ECBF contributes to the environmental objectives of climate change mitigation, circularity and biodiversity. To determine greenhouse gas emission savings of its investment targets, ECBF uses the Nova-Institute, a research consultancy working on the transition to renewable carbon.
“Before ECBF invests, we have the institute carry out an assessment on greenhouse gas emission savings. If potential investment targets cannot demonstrate these savings in a measurable and evidence-based way, ECBF won’t invest,” Frentz adds.
This science-based approach is important not only for SFDR compliance, but also because the ECBF plays a key role in the European bioeconomy. On November 27, the EU released its updated Bioeconomy Strategy, explicitly highlighting the ECBF as a key vehicle for strategically advancing Europe’s bioeconomy. This significant role, along with other aspects, enabled the fund to attract investors from the corporate sector, institutional circles and family offices, among others.
Innovations in the bioeconomy sector carry substantial economic weight, especially with growing international competition. Both the United States and China are accelerating the development of their bioeconomies, including bio-based manufacturing.
According to the Commission, the EU circular bioeconomy employs more than 17m people (around 8% of EU jobs) and in 2023 had a value of €2.7 trillion. But for VCs looking to invest and for startups hoping to receive funds in the sector, demands on data, transparency and impact verification that come with regulatory sustainability disclosure may prove challenging.
Bostjan Bozic, chief operating officer at agritech startup Trapview, advises that both VCs and startups should keep things simple. “The best advice is to not over design or over engineer the system. It's good if sustainability is already included in the product design phase, not treated as an afterthought,” he tells Sifted.
If this law will help VCs be more efficient in reporting, then their portfolio companies can be more efficient too. This will also bring some time savings and resource savings for everyone in the chain.
“I would say that this is a very general observation for any company, even the multinationals. If you start with sustainability in mind, it's much easier.”
Bozic is concerned that the ESG agenda has slowly been diluted on the highest political level over the past two years.
“It started in February last year, when the European Parliament did not pass the law on reducing pesticides by 2030. This was the first huge step down from the agenda,” he says.
Bozic is disappointed no significant advancement in the achieving of the global climate goals were made at COP30. Prior to the summit, only a third of countries submitted new plans to cut carbon, despite all being required to do so. The COP30 deal also had no direct reference to fossil fuels or deforestation.
If this law will help VCs be more efficient in reporting, then their portfolio companies can be more efficient too. This will also bring some time savings and resource savings for everyone in the chain.
“No country is willing to commit themselves to such stringent goals, but utterly essential if we are to have a realistic chance of meeting our climate targets. In the light of the current European geopolitical situation I see a huge shift of generalist VCs going into defence, resilience and sovereignty but not really into sustainability,” Bozic says.
Still, he remains hopeful that regulation can help steer capital back toward impact. He is optimistic the developments of SFDR 2.0 could provide a turning point to make it easier for VCs to invest in impact. “If this law will help VCs be more efficient in reporting, then their portfolio companies can be more efficient too. This will also bring some time savings and resource savings for everyone in the chain,” he says.
For Thomas Gruebler, chief strategy officer and cofounder of wildfire detection startup OroraTech, impact investing is becoming more crucial than ever, and will only continue to be so with the proposal of SFDR 2.0.
“The planet is heating up so we can only do everything to prepare to live in this future,” he tells Sifted. “We are in this space where impact startups are not only here because it’s ‘nice to do’ but it is actually very important.”
The most important thing VCs can do following the proposed changes of SFDR 2.0 is to follow the money and the competition, he adds.
“You are in competition with a global financial market and it’s all about the money. If you can assist someone to make money with impact then go for it. We [OroraTech] can do this with CO2 funds for example.”
We are in this space where impact startups are not only here because it’s ‘nice to do’ but it is actually very important.
However, it is important for VCs and startups to both focus on what is coming, he adds. “Most solutions nested under the impact umbrella are needed sooner or later. For example, investors who made impact investments in remote childcare in 2015, got their profit after the pandemic hit. Impact investing is a way of predicting the future.”
Despite already measuring impact in line with the SFDR 2.0 and generating KPIs related to green house gas savings, circularity and biodiversity from its investments, ECBF will advance its impact investing approach.
The bioeconomy fund is hoping to start raising a second investment fund next year to bring even more opportunities of impact investment, explains Frentz, in addition to their current fund of €300 million.
The SFDR 2.0 mentions for the first time a theory of change that sustainable products need to have while the previous version did not mention this concept at all.
“We would like to have an even stricter impact measurement system. For example, we would like to go and use more biodiversity indicators than we are using already and define biodiversity targets.
“The SFDR 2.0 mentions for the first time a theory of change that sustainable products need to have while the previous version did not mention this concept at all. For the next fund, we want to have a more profound theory of change from which we then derive the different GHG savings, biodiversity and circularity targets.
“We want to achieve a systemic change, moving from a fossil based economy to a circular one.”
